We’re in a massive bubble: This is when it’ll pop

‘The most important event of your investing lives’ is coming, says legendary investor. Here’s how to prepare for a terrifying time.

| More on:
a man in a business suit leans in to burst a huge bubble with a pin, indicating a major share market crash

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

One of the world’s most influential investors has warned share markets are in the late stages of a massive bubble.

And that it will all end in tears very soon.

GMO co-founder Jeremy Grantham wrote in a letter to investors this week that the very long bull market that started in 2009 has now “matured” into a “fully fledged epic bubble”

“Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behavior, I believe this event will be recorded as one of the great bubbles of financial history – right along with the South Sea bubble, 1929, and 2000.”

The S&P/ASX 200 Index (ASX: XJO) and S&P 500 Index (INDEXSP: .INX) have climbed 48% and 68% respectively since March.

Governments have poured in unprecedented support and central banks have erased interest rates to get the world through COVID-19. But none of that matters now, according to Grantham, because this bubble is about to burst.

“Make no mistake – for the majority of investors today, this could very well be the most important event of your investing lives,” he said.

“Speaking as an old student and historian of markets, it is intellectually exciting and terrifying at the same time.”

Grantham reminded his readers that the Nasdaq Composite (INDEXNASDAQ: .IXIC) fell 82% when the tech bubble popped 20 years ago.

“And here we are again, waiting for the last dance and, eventually, for the music to stop.”

He took the unstoppable rise of Tesla Inc (NASDAQ: TSLA) as a demonstration of a bubble at play.

“As a Model 3 owner, my personal favorite Tesla tidbit is that its market cap, now over US$600 billion, amounts to over US$1.25 million per car sold each year versus US$9,000 per car for General Motors Company (NYSE: GM),” Grantham said.

“What has 1929 got to equal that?”

When will this bubble burst?

Trying to predict the end of a bubble is always a mug’s game, according to Grantham. But he took a stab at when he thought share investors might get a rude wake-up call.

“My best guess as to the longest this bubble might survive is the late [northern] spring or early summer, coinciding with the broad rollout of the COVID vaccine,” he said.

“At that moment, the most pressing issue facing the world economy will have been solved. Market participants will breathe a sigh of relief, look around, and immediately realise that the economy is still in poor shape, stimulus will shortly be cut back with the end of the COVID crisis, and valuations are absurd.”

One big sign of a bubble imminently about to burst is a “rising hostility toward bears”.

“In the last few months the hostile tone has been rapidly ratcheting up,” said Grantham.

“The irony for bears though is that it’s exactly what we want to hear. It’s a classic precursor of the ultimate break – together with stocks rising, not for their fundamentals, but simply because they are rising.”

According to Grantham, the bursting of a bubble is hard to pick because it often happens when conditions for stocks are still excellent.

“The great bull markets typically turn down when the market conditions are very favorable – just subtly less favorable than they were yesterday. And that is why they are always missed.”

The entire financial industry is rigged to be bullish

Even with a crash looming, bears will always be in the minority, according to Grantham.

“Every career incentive in the industry and every fault of individual human psychology will work toward sucking investors in.”

You would always see the big investment houses and fund managers be bullish because it’s “good for business and intellectually undemanding”. 

“It is appealing to most investors who much prefer optimism to realistic appraisal, as witnessed so vividly with COVID,” Grantham said.

“And when it all ends, you will as a persistent bull have overwhelming company. This is why you have always had bullish advice in a bubble and always will.”

What to do with your shares to prepare for a bubble burst

A major feature of bubbles is a massive disparity between the valuations of different asset classes or sectors, according to Grantham.

This time around, this gap is between growth and value stocks.

“Those at the very cheap end include traditional value stocks all over the world, relative to growth stocks. Value stocks have had their worst-ever relative decade ending December 2019, followed by the worst-ever year in 2020, with spreads between growth and value performance averaging between 20 and 30 percentage points for the single year!”

Another disparity is between shares in the US and developing nations. Australian stocks often mimic the fortunes of the US market.

“Emerging market equities are at 1 of their 3, more or less co-equal, relative lows against the US of the last 50 years.”

So Grantham recommends positioning your portfolio to take advantage of both of these imbalances.

“We believe it is in the overlap of these two ideas, value and emerging, that your relative bets should go, along with the greatest avoidance of US growth stocks that your career and business risk will allow.”

Tony Yoo has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of and recommends Tesla. The Motley Fool Australia has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

More on Share Market News

a woman holds her hands to her temples as she sits in front of a computer screen with a concerned look on her face.
Bank Shares

What’s moving the CBA share price this week?

CommBank shares traded ex-dividend on Wednesday this week.

Read more »

A woman stands on the roof of a city building as papers fly in the sky around her.
Share Market News

Here are the 3 most heavily traded ASX 200 shares on Friday

We take a look at the most traded ASX 200 shares today...

Read more »

Two men in suits face off against each other in a boing ring.
Cryptocurrencies

The Aussie-born crypto platform taking on Ethereum

A new platform is being launched by a 25-year-old Aussie millionaire.

Read more »

A woman shouts through a megaphone.
Share Market News

Earnings preview: Here’s which ASX shares are reporting today

Wondering which ASX companies are releasing results on Friday?

Read more »

A happy male investor turns around on his chair to look at a friend while a laptop runs on his desk showing share price movements
Share Market News

5 things to watch on the ASX 200 on Friday

The ASX 200 looks likely to have a decent finish to the week...

Read more »

A group of happy office workers throw papers in the air and cheer after seeing the Latrobe Magnesium price skyrocket 38%
Share Market News

Here are the top 10 ASX 200 shares today

These ASX 200 shares outperformed all others on Thursday.

Read more »

Three male athletes sprint on an athletics track with the sun low on the horizon behind them representing the race between ASX lithium shares to outperform
Share Market News

Here are the 3 most heavily traded ASX 200 shares on Thursday

Our most traded ASX 200 share today is down by more than 5%.

Read more »

Bear market
Share Market News

Here’s why one big bad bear is suggesting the stock market could crash by 50%

One strategist thinks markets haven't bottomed.

Read more »